On August 26, 2005, the Securities and Exchange Commission (SEC) approved amendments to NASD Rule 3150, regarding reporting requirements for clearing firms, and NASD Rule 3230, regarding requirements for clearing agreements.1 The new rule text is contained in Attachment A and is effective on February 20, 2006.

Questions/Further Information

Questions concerning this Notice may be directed to George Walz, Vice President and Director, National Examination Program, Department of Member Regulation, at (202) 728-8462; or Shirley H. Weiss, Associate General Counsel, Office of General Counsel, Regulatory Policy and Oversight, at (202) 728-8844.

Background

By way of background, some introducing firms choose not to contract for clearing
services directly with a clearing firm. The reasons vary. For example, the firm may not
do sufficient business to satisfy clearing firm financial and other requirements to
support a separate clearing agreement. In such cases, the firm may contract for clearing
services with an introducing, or "intermediary" firm that, in turn, contracts directly with
a clearing firm for clearing services. Firms that contract for clearing services with an
intermediary firm are often referred to as "piggybacking" firms, or "piggybackers."

Under this arrangement, only the intermediary firm has a contractual arrangement
with the clearing firm, which clears for both the intermediary firm and the
intermediary firm's piggybacking firm(s). Under current practice, the intermediary firm
may assign account numbers to the piggybacker's accounts (both proprietary and
customer accounts) that do not identify them to the clearing firm as belonging to a
piggybacking firm. For example, the intermediary firm may assign account numbers
that identify these accounts as branch offices of the intermediary firm.

Although these piggybacking arrangements may satisfy the business needs of the
parties—the clearing firm, the intermediary firm, and the piggybacking firm—they may
impede NASD regulatory programs and may cause problems for the clearing firm. For
example, under Rule 3150, clearing firms are required to report certain data to NASD
for purposes of the surveillance component of its National Examination Program (NEP).
In fulfilling its reporting obligation under Rule 3150, a clearing firm whose clients
include intermediary firms that have contracted with piggybackers may be reporting
the combined data of the intermediary firm and its piggybackers as only belonging to
the intermediary firm. In such cases, NASD staff is not able to distinguish between data
belonging to the intermediary firm and data belonging to the piggybacking firm(s) for
purposes of conducting surveillance.

In addition, this inability to separate the piggybacking firm data can, and already
has, become a serious issue if an intermediary firm goes into SIPC (Securities Investor
Protection Corporation) liquidation. If the data from the intermediary and
piggybacking firms are not distinguishable, the clearing firm will be unable to facilitate
the orderly transfer of accounts without doing time-intensive research and creating a
special program to separate accounts belonging to the intermediary firm and its
piggybacker(s).

Discussion

To resolve these issues, NASD has adopted amendments to Rule 3150 (governing
reporting requirements for clearing firms) and Rule 3230 (governing clearing
agreements) that would permit regulators and clearing firms to distinguish between
data belonging to an intermediary firm and data belonging to its piggybacker(s).

NASD Rule 3150. The amendments to Rule 3150 require clearing firms to report data
to NASD about each piggybacking firm separately from the intermediary firm's data.
These requirements will apply to the data pertaining to the proprietary and customer
accounts of piggybacking firms only if the piggybacking relationship with the
intermediary firm was established on or after February 20, 2006.

NASD Rule 3230. The amendments to Rule 3230 require intermediary firms to maintain
data in such a way as to enable NASD and the clearing firm to be able to identify the
data pertaining to the proprietary and customer accounts of the intermediary firm and
the data pertaining to the proprietary and customer accounts of any piggybacking firm.
These amendments will enable NASD staff to surveil data reported by piggybacking
firms as part of NASD's NEP Surveillance program and facilitate any future SIPC
liquidations. These requirements will apply to the data belonging to the proprietary
and customer accounts of any piggybacking firm only if the piggybacking relationship
was established on or after February 20, 2006.

(b) Each member that is a clearing firm is required to report prescribed data to NASD under this Rule in such
a manner as to enable NASD to distinguish between data pertaining to all proprietary and customer accounts of an
introducing member and data pertaining to all proprietary and customer accounts of any member for which the
introducing member is acting as an intermediary in obtaining clearing services from a clearing firm. The reporting
requirements of this paragraph (b) shall apply to the proprietary and customer accounts of members that have
established an intermediary clearing arrangement with an introducing member on or after February 20, 2006.

[(b)](c) Pursuant to the Rule 9600 Series, NASD may in exceptional and unusual circumstances, taking into
consideration all relevant factors, exempt a member or class of members unconditionally or on specified terms from
any or all of the provisions of this Rule that it deems appropriate.

* * * * *

3230. Clearing Agreements

(a) through (g) No change.

(h) All clearing agreements shall require each introducing member to maintain its proprietary and customer
accounts and the proprietary and customer accounts of any member for which it is acting as an intermediary in
obtaining clearing services from the clearing firm in such a manner as to enable the clearing firm and NASD to
identify data belonging to the proprietary and customer accounts of each member. The requirements of this
paragraph (h) shall apply to intermediary clearing arrangements between a member and an introducing member
that are established on or after February 20, 2006.